Nigerian Banks at Severe Risk from Oil Price Slump, Coronavirus

Nigerian banks' credit profiles face severe risks from
the oil price slump and operating environment disruption due to the coronavirus
pandemic, Fitch Ratings says. Asset quality deterioration linked to high
exposures to the oil and gas sector is the biggest threat to ratings.

Operating environment risks inevitably rise in Nigeria
when oil prices fall. Oil exports represent 95% of the country's export revenue
and strongly influence the broader economy. Falling oil revenue may also lead
to further currency devaluation. Accordingly, the slump in oil prices raises
the risk of a recession. Operating environment risks are compounded by economic
and financial market disruption amid measures to counter the pandemic, putting
pressure on all borrowers.

Forbearance measures announced by the Central Bank of
Nigeria (CBN) will provide some relief to businesses and households and help
the flow of credit into the economy. This will support reported asset quality
metrics in the short term (the average Stage 3 loans ratio for Fitch-rated
banks was 5.7% at end-2019) but asset quality could deteriorate significantly
depending on the duration and severity of the oil price shock and coronavirus
turmoil.

Fitch recently downgraded three Nigerian banks'
Long-Term Issuer Default Ratings (IDRs) to 'B' from 'B+' and placed all 10
Nigerian banks' Viability Ratings and IDRs on Rating Watch Negative, reflecting
our expectation that banks will face material pressures from the weaker
operating environment in the coming months (see here). The resilience of banks'
asset quality, profitability and capital during the economic downturn will
influence, among other considerations, how we resolve the Rating Watches.

The oil and gas sector represented about 30% of
Nigerian banks' gross loans at end-3Q19. Accordingly, loan quality is highly
correlated to oil prices, as seen during previous oil price shocks in 2008-2009
and 2015-2016. Impaired loans have decreased since 2017 due to rising oil
prices as well as recoveries and write-offs, but the current shock could lead
to a significant increase. Any closures of oil fields due to a collapse in
global oil demand would exacerbate the impact.

Asset quality risk is exacerbated by the rapid step-up
in lending to certain riskier sectors, including retail, agriculture and SMEs,
which banks took on to help meet the minimum loans-to-deposit ratio of 65%
introduced in 2019. Unhedged US dollar loans to corporates expose banks to
potential further naira devaluation, pushing up debt-servicing costs.
Devaluation also affects SMEs, particularly in the manufacturing and services
sectors given Nigeria's dependence on imports for raw materials and finished
goods. However, the direct impact of devaluation on banks' regulatory capital is
mitigated by their net long foreign-currency positions.

Problem loans (Stage 2 and Stage 3) averaged 23% of
gross loans for Fitch-rated banks at end-2019, which is high. Stage 2 loans
averaged 17% and include a large proportion of loans to the oil and gas sector
already restructured due to the 2015 oil price shock.

The CBN's forbearance measures include the
restructuring of loan tenors and terms for households and corporates most
affected by coronavirus disruption, including loans to the oil, manufacturing
and agriculture sectors. Banks will not have to classify these as Stage 2 or
Stage 3 loans and this will mask the true extent of asset quality
deterioration.

We expect a rise in restructured loans to 25%-30% of
gross loans in 2020-2021 as banks extend tenors and lower interest rates to
help borrowers. This could lead to a significant rise in impaired loans if low
oil prices and severe coronavirus disruption are long-lasting. Loan-loss
coverage of total loans of 4.9% at end-2019 was modest given loan concentrations
by sector and operating environment risks. Loan-loss coverage of Stage 3 loans
was reasonable at 97%, but coverage of problem loans was much lower due to low
coverage of Stage 2 loans.

The weighted-average cost of risk for Fitch-rated
Nigerian banks rose by 200bp during the 2015 oil price shock. We do not rule
out a similar increase in 2020. The oil price shock and sharp macroeconomic
deterioration will lead to higher expected-credit-loss provisions, undermining
banks' profitability. Lower lending growth and subdued business activity
negatively affecting non-interest revenues will also weigh on profitability.

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